What is Performance Based Vesting of Stock Options?

Vesting is a time bound stock ownership plan that allows employees, directors, owners, and entrepreneurs to acquire equity in the firm they're working for. The Vesting Plan decides how and when the owners and employees gain access to or keep their shares. Introduction of a performance based criterion to this Vesting Plan will make this a Performance Based Vesting structure. Instead of time duration, the stocks would only be vested if they hit certain targets within a specified period like a quarter.

Examples of Performance Based Vesting

Regular Vesting Example 

A new employee is awarded 1000 stocks in the company as part of the pay package, but the employee only gains ownership of these stocks at the rate of 25% per year. This Vesting Plan, a.k.a the Graded Vesting Model, would be completed in 4 years with the employee gaining ownership of 250 shares per year, conditional upon the employees continued employment with the company. This is a regular time bound vesting schedule 

Performance Based Vesting Example 

Suppose an employee gets offered 1000 stocks of a company that are publicly trading at $80/share. The vesting is conditional on the stocks hitting the $90 mark for the current quarter. 10% of the 1000 shares get vested every quarter only if the stock price hits a predetermined goal for that quarter. This is Performance Based Vesting of stock units. The employee can only gain ownership when the quarterly performance goals of the stocks are met. Vesting plans are vastly different for owners and employees and operate on different conditional criteria and time bound scales. 

Advantages of Performance Based Vesting 

Vesting schemes allow owners and employees to benefit from improved securities performance even as it safeguards the interests of the firm in the long run by making it conditional upon stringent criteria. In business verticals with high churn rates, where expecting employees to stay loyal for years isnt feasible, a Performance Based Vesting plan can attract top talent as well as act as a sop to get the best out of employees. Since the Vesting Plan is tied to the performance or other goals related to company's stocks, which in turn is tied to the performance of the company, i.e., the collective performance of individuals, it keeps employees on their toes to give their best to the company to achieve the conditional predetermined goals. It is a way of rewarding founders working for equity in the company without cash strapping a budding business.